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Making Climate Change and Trade Mutually Supportive

Policy brief by Messerlin, Patrick/ ARTNeT, 2010

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A few years ago, the relations between the climate and trade communities were marked by mutual ignorance at best, and more often by deep hostility. Now things are changing. The trade community is realizing that climate change concerns will be high on the political agenda for a long time to come. The climate community is realizing that climate policies will face fierce opposition from four-fifths of human kind if it costs too much in terms of growth and of trade, its main channel. However, many fears and doubts still abound. This policy brief reviews what the trade community and the climate community have in common, and what the possibilities offered to them are, but also the challenges they will have to face.

ARTNeT Policy Brief No. 26 1


ARTNeT POLICY BRIEF


Patrick Messerlin* Brief No. 26, July 2010


Making climate change and trade mutually supportive


* Patrick Messerlin is a Director, Groupe d’Economie Mondiale at Sciences Po. This brief is based on Messerlin. P. (2010). The technical support


provided by ESCAP and the International Development Research Centre, Canada, during the preparation of this brief is gratefully acknowledged.


The views presented are those of the author and do not necessarily reflect the views of the United Nations, the author’s employer or other ARTNeT


members and partners.


Asia-Pacific Research and Training Network on Trade • www.artnetontrade.org • Tel: +66 2 288 2067 • Email: artnetontrade@un.org


Introduction


A few years ago, the relations between the climate and


trade communities were marked by mutual ignorance at


best, and more often by deep hostility. The climate


community did not want to be hindered by trade


constraints. The trade community was so afraid of the


damage that climate policies could do to the


multilateral trade regime that it was adamantly opposed


to any consideration of such concerns. Mutual


destruction looked inevitable.


Now things are changing. The trade community is


realizing that climate change concerns will be high on


the political agenda for a long time to come. The


climate community is realizing that climate policies will


face fierce opposition from four-fifths of human kind if it


costs too much in terms of growth and of trade, its main


channel.


However, many fears and doubts still abound. The trade


community remains obsessed by the host of putative


conflicts raised by creative trade lawyers, forgetting that


other domains of international trade law are full of


conflicts that have never materialized. The climate


community has not yet fully realized how easy a prey it


is for protectionist interests, at great cost to climate


change goals. For example, the European Commission


(2009) has formulated a list of industries with “significant


risk of carbon leakage” that includes sectors such as


manufacturing of wines, clocks, bicycles and underwear.


These quite surprising outcomes are easy to explain; one


of the criteria used by the European Commission for


drawing up the list is the importance of trade for the


sectors examined. This criterion, driving the selection of


80 per cent of the sectors in the list, has nothing to do


with climate change, but it is honey for protectionist-


minded sectors.


1. Climate and trade communities: So many things
in common


The main ingredient that is still lacking in the climate and


trade debate is full recognition of the many things that


the climate and trade communities have in common.


First, they share a common problem – each has to deal


with a global “public good”. Climate change is a public


good; countries unwilling to contribute to climate


change goals undermine the results of those making


efforts. Freer trade is a public good; its benefits are


bigger and faster to emerge if all the countries move


together.


Second, the two communities have common foes as


illustrated by the above mentioned European Com-


mission list – the firms willing to slow down climate policies


by using protectionism and those willing to slow down


trade liberalization by using climate change excuses.


Third, they have emerging common friends – those firms


willing to grasp the opportunities of delivering goods that


are both cleaner (good for the climate) and cheaper


(good for trade) as well as countries such as Germany or


China are building up comparative advantages in


environmentally-friendly goods.


Last but not least, the world climate regime has to


develop in a multilateral framework, just as the trade


regime did. There is one Earth, but the Copenhagen


Conference has made it clear that no country is ready


to surrender its sovereign rights. The world carbon price


or tax is an objective that should be aimed for, but it will


emerge in a future as distant as worldwide free trade.


The existence of so many fundamental similarities


strongly suggests that the multilateral climate regime


should not be so different from the multilateral trade


regime. In the following paragraphs, it is argued that the


climate community would greatly benefit from adopting


the two key principles of the multilateral trade regime. It


is also argued that benefits go both ways; the climate


community could design some instruments that could be


repatriated in the multilateral trade regime to its upmost


benefit. Mutual support emerges as highly desirable.


2. From the trade community to the climate
community


The climate community should borrow the multilateral


trade regime’s two key principles – “national treatment”


for disciplining carbon border taxes and “most-favoured


nation” for disciplining carbon tariffs.




2 ARTNeT Policy Brief No. 26


ARTNeT POLICY BRIEF


(a) National treatment


The climate community worries about carbon leakage.


Arguably, carbon border taxes (CBTs) are the best


instrument to fight carbon leakage; why would firms


located in a country shift their dirty production to foreign


countries if, once re-imported, their products would pay


the country’s domestic carbon taxes? If CBTs reassure
the climate community, they make the trade community


nervous. The trade community should be reminded that


such a system has been routinely used with great


success by trading partners enforcing very different rates


of value added tax (VAT) during the past four decades.


Thus, there is nothing wrong with CBTs if – this “if” is


crucial – they are properly enforced, as in the VAT case.


This condition requires the principle of national


treatment, which means that a country should impose


the same domestic tax on imported goods and on


similar products produced domestically. Specifically, it


requires the country exporting goods to eliminate its


domestic carbon taxes (if any) on exported products,


while the importing country imposes its own domestic


carbon taxes (if any) on imported products. Evidence


from the European cap-and-trade regime suggests that


carbon taxes in the dirtiest sectors would be equivalent


to VAT rates of 3 per cent to 6 per cent – not insignificant


numbers, but not large ones either.


In this context, it is interesting to estimate the potential


impact of carbon border taxes. The table suggests three


main results. First, clearly, mutual destruction is a


possibility. Trade-based border taxes on imports result in


massive deterioration of the situation – remarkably – of


almost all the countries, to the point of putting at risk


world growth; hence the willingness and/or capacity to


pursue climate change policies. Second, while the


impact of specific-based border taxes may be less


dramatic it hurts most developing countries, ensuring


political international turmoil.


Last but not least, two border tax regimes have a much


lower impact on trade: (a) the two-way border tax


regime; and (b) the ‘no border tax’ regime. The choice


between these two regimes depends largely on whether


or not developed countries want to do practice what


they preach. If one believes what developed countries


preach, they are cutting their carbon emissions for the


sake of human welfare. Their preferred choice should


then be the ‘no border tax’ regime. Developed countries


would accept a small decline of their exports because it


minimizes the decline of the low- and middle-income


developing countries’ exports. The ‘no border tax’


regime thus emerges as the preferable option from


the joint points of view of climate change (the targeted


CO
2
cut is achieved in developed countries) trade and


development; this is mutual support at its best.


(b) Most-favoured nation


Such a principle would ban the imposition of carbon


tariffs on imports from only certain countries, i.e., China,


India or other key emerging economies. It is crucial to


distinguish between carbon tariffs and carbon border


taxes; carbon tariffs do, in fact, discriminate against


some countries, and they are not defined by the level of


domestic carbon taxes. The most-favoured nation


principle should be a pillar of the multilateral climate


regime, because carbon tariffs are totally counter-


productive from a climate perspective for two reasons.


First, they assume that developed countries import most


of their dirty products from developing countries. This is


not the case, because developing countries still export


mostly goods with relatively low carbon intensity, from


clothing to assembled products. Second, carbon tariffs


would generate a “dual” world economy with a slowly


growing trade between clean countries, and a rapidly


growing trade between dirty countries – not precisely


what the climate community would like to promote.


Interestingly, a trade-centred (and selfish) argument


reinforces these two reasons. Assume, for example, that


rich countries impose carbon tariffs on Chinese exports of


dirty products (on the top of CBT). This treatment will


create strong incentives among Chinese firms to


upgrade as quickly as possible those products they want


Estimated impact of alternative border tax regimes on total industrial exports


(Unit: Per cent changes)


Border tax regimes
a


United States EC
Developing


Brazil China India
countriesb


Only on imports (trade-based) -10.1 -23.2 -14.8 1.9 -20.8 -16.0


Only on imports (specific-based) -6.5 -6.6 -3.2 -2.5 -3.4 -3.2


Two-way tax (specific-based) 0.0 0.5 -2.0 -0.6 -1.8 -2.1


No border tax -2.3 -2.1 -0.1 1.0 -0.9 -0.3


Source: Mattoo and others, 2009. Developed countries are assumed to reduce unilaterally their CO
2
emissions by 17 per cent


Note: EC = European Commission.
a Two-way border tax – elimination of the carbon tax imposed by the exporting country combined with the imposition of the carbon tax


imposed by the importing country. Trade-based BT: the specific carbon tax of the importing country is applied on the carbon content of


the exporting country on imports from the developing countries. Specific-based BT: the specific carbon tax of the importing country is


applied on the carbon content of the importing country on imports from the developing countries and specific-based.
b Low- and middle-income developing countries.




ARTNeT Policy Brief No. 26 3


ARTNeT POLICY BRIEF


to export to the rich countries. In other words, carbon


tariffs will accelerate the emergence of Chinese


competitors in the high-end products – exactly as


voluntary export restraints and antidumping measures


accelerated the technological upgrading of Japanese


and Korean products from the 1970s to the 1990s. This is


not exactly what the supporters of carbon tariffs are


hoping for.


3. From the climate to the trade community


What could the climate community teach the trade


community? Of course, this part is more hypothetical
because the climate regime is still a blank page. Clearly,


however, a sound multilateral climate regime could help


the trade community with several crucial aspects.


(a) Better adjustment policies


The multilateral trade regime has failed to put in place


sound instruments for supporting the adjustment efforts


required by changing economic conditions. It relies on


measures such as antidumping or safeguards, which


have been amply proven to be both ineffective (they


do not promote adjustment) and costly to consumers


(and even to the firms triggering such measures). The


same would inevitably happen if the climate community


were to adopt similar instruments for addressing climate


change-related adjustments.


At this stage, the climate community has the opportunity


to design better instruments – be it well-targeted


subsidies, public regulations or self-regulations – for


addressing the adjustment problems to be met by


producers of carbon-intensive products. If successful, the


climate community would have provided a great


service to the trade community, which could then


renovate its own machinery by adopting similar


instruments for trade-related adjustment problems.


(b) Differentiated treatment of developing countries


The climate community has already adopted the notion


of “common but differentiated responsibilities” when


dealing with developing and least developed countries.


This notion echoes the “special and differentiated


treatment” (S&DT) in the multilateral trade regime.


However, S&DT can be best described as a trap for


developing countries; it is not generous when truly


needed, and it is generally designed in such terms that


it generates perverse impacts (if any) on both the


alleged beneficiaries and the developing countries


excluded from its scope.


The main reason for such negatives effects is that the


trade community has been unable to design a sound


mechanism for “graduating” successful developing


countries. The climate community should therefore be


careful not to duplicate such a mistake; instead, if


deemed necessary, it should design sound, predictable


and progressive conditions of the “graduation” of


developing and least developed countries.


(c) Negotiating techniques


A last source of inspiration that the trade community


could draw from climate diplomacy concerns


negotiating techniques. The climate community has


already begun to negotiate on a “plurilateral” basis, that


is, a core of key large countries, with a few more nations


representing well-defined groups of small countries. The


trade community would be well-advised to adopt similar


techniques for concluding the Doha Round.


4. Challenges ahead


Generally speaking, the climate community should feel


at ease within the broad World Trade Organization


principles. If that community wants to have its own


multilateral treaty, it should make sure the treaty is built


on the same basic principles. Meanwhile, the trade


community should grasp the opportunities to benefit


from the improved disciplines that the climate


community could design, in order to address the


systemic current failures of the multilateral trade regime.


That said, although immensely beneficial, mutual support


raises serious challenges because climate change


policies raise huge difficulties in terms of implementation.


The following four issues require particular care.


(a) Defining “similarity” or “likeness”


National treatment means that countries rely on


domestic information – the one they know best. This is a


highly desirable feature. However, it falls short of


providing a workable definition of “similarity” between


(or “likeness” of) foreign and domestic products, and


production processes. Unfortunately, to say the least, the


multilateral trade regime does not provide any firm


guidance on this issue.


As a result, the climate community has a key role to play


in shaping such a definition. It should be very careful not


to be captured by definitions of “similar” that would


favour vested interests to the detriment of climate


change goals. This implies that similarity should be based


on scientific evidence in two ways. First, such evidence


should be the only criterion for defining carbon intensive


sectors. This is a key step for limiting risks of protectionism.


However, it is also a crucial step for the climate


community because it helps to simplify the otherwise


mind-boggling complexity of climate policies, and to


focus on the sectors that are the true source of


problems. Second, scientific evidence should be used to


build “clusters” of production processes considered to


have similar carbon-intensity and thus subject to the


same carbon tax rate.


(b) Taking into account production and process


methods


These two steps are critical for addressing, in a


pragmatic way, the problem of production and process


methods (PPMs). The logic of climate change problems




4 ARTNeT Policy Brief No. 26


ARTNeT POLICY BRIEF


What is ARTNeT? The Asia-Pacific Research and Training Network on Trade (ARTNeT) is an open


regional network of research and academic instiutions specializing in international trade policy


and facilitation issues. Network members currently include over 25 leading national trade


research and academic institutions from as many developing countries from East, South,


and Southeast Asia and the Pacific. IDRC, UNCTAD, UNDP, ESCAP and the WTO, as core


network partners, provide substantive and/or financial support to the network. The Trade


and Investment Division of ESCAP, the regional branch of the United Nations for Asia and


the Pacific, provides the Secretariat of the network and a direct regional link to trade policymakers and other


international organizations.


ARTNeT aims at increasing the amount of policy-oriented trade research in the region by harnessing the


research capacity already available and developing additional capacity through regional team research


projects, enhanced research dissemination mechanisms, increased interactions between trade policymakers


and researchers, and specific capacity-building activities catering to researchers and research institutions from


least developed countries. A key feature of the network’s operation is that its research programme is discussed


and approved on an annual basis during a consultative meeting of policymakers, research institutions and other


stakeholders. For more information, please contact the ARTNeT Secretariat or visit www.artnetontrade.org.


makes it inevitable that PPMs as well as products per se


must be taken into consideration. Two “like” goods


produced by a dirty and a clean production process are


not similar from a climate perspective. This feature makes


the trade community nervous. However, that community


should also recognize that it implicitly takes into account


production processes when it allows the imposition of


different antidumping duties of “like-products” produced


by different firms. The risk is thus not a matter of


principles, but of sound implementation.


If these two steps are not followed, it creates the risk of


denying the notion of likeness. This would hurt the trade


regime. In addition, it would also harm the climate


regime because it would require the impossible task of


managing an enormous number of “products times


processes” that are subject to a host of different carbon


taxes. Developing these two steps based on scientific


evidence is thus a common interest of the climate and


trade communities. Doing so in a multilateral framework


would make the similarity definitions even more


transparent and unbiased.


(c) How to define carbon border taxes?


The way that carbon border taxes will be defined is


crucial for developing countries. Ensuring a level playing


field is not a simple matter in the case of a public good


because it faces two constraints: (a) from an economic


perspective, past emissions have to be taken into


account as well as present and future emissions; and


(b) from a political perspective, the level of taxation


should not harm growth too strongly if worldwide support


is sought. Of the three possible ways of defining carbon


border taxes, the burden on developing countries


could range from one to two or even three taxes,


depending on the definition chosen. Offering the best


outcome from a joint climate, development and trade


perspective requires the definition of border taxes in ad


valorem terms.


(d) Facing the unexpected


This point is based on the implicit assumption of perfect


forecasts in climate change matters. This assumption is


not met at the regional or local level. For example,


available forecasts on more frequent and severe


droughts in certain regions during the coming 20 to


50 years diverge widely, depending on the model


used. An efficient way to address the problems of


increased scarcity of water, and of its unequal


distribution in the world is more trade between water-rich


and/or water-efficient countries and the other countries


– meaning the opening of their agricultural sectors


(which use 70 per cent to 80 per cent of water


resources) by the developed countries. In short, freer


trade emerges as the cheapest source of insurance


against unexpected shocks in climate change.


To conclude, rather than being afraid of each other, the


climate and trade communities should realize how much


they will lose if they do not cooperate, and how much


they will gain if they support each other.


References


European Commission (2009). “Draft Commission Decision


on determining, pursuant to Directive 2003/87/EC of the


European Parliament and of the Council, a list of sectors


and subsectors which are deemed to be exposed to a


significant risk of carbon leakage”. Available at http://


ec.europa.eu/environment/climat/emission/pdf/


draft_dec_carbon_leakage_list16sep.pdf


Mattoo, A., A. Subramanian, D. van der Mensbrugghe and


J. He. (2009). “Reconciling climate change and trade


policy”, Working Paper No. 09-15. Peterson Institute for


International Economics, Washington, D.C.


Messerlin, P. (2010). “Climate change and trade: From mutual


destruction to mutual support”, Groupe d’Economie


Mondiale Working Paper, April 2010. Sciences Po, Paris.


Available at http://gem.sciences-po.fr.




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